iPolitics Insights

It’s a common metaphor in financial markets: Central bank rates take the elevator down in times of crisis, and the escalator back up in a recovery.

Janet Yellin, chair of the U.S. Federal Reserve, chose to take the stairs.

In the financial crisis of 2008, the fed funds rate plunged from 5 per cent to a range of 0.00 to 0.25 per cent. Seven years later to the day on Wednesday, the Fed gingerly raised its bank rate by 25 basis points to a range of 0.25 to 0.50 per cent.

The Fed had signaled it would raise rates by the end of the year, and did so in a very incremental way, with Yellin noting that “the economic recovery has come a long way, though it is not complete.” The stock market, which hates surprises and was expecting the rate increase, surged on the news in both New York and Toronto.

Cheap liquidity has driven the recovery in both the U.S. and Canada, and the Fed’s financial tools were by no means limited to low interest rates. Under Yellin’s predecessor, Ben Bernanke, the Fed had three rounds of “quantitative easing” — buying back bonds at the rate of $85 billion a month at the peak of QE III — flooding the market with several trillion dollars in cash before “tapering” the program. It reached the point where then-Finance minister Jim Flaherty was complaining to his U.S. counterpart, Treasury Secretary Tim Geithner, that there was too much cheap money in the market.

Bank of Canada Governor Stephen Poloz isn’t without some creative means of his own. In a Toronto speech last week, he said the Bank would consider negative interest rates to stimulate the economy in the event of another downturn. This is already the case in some European countries — and if it works for the Swiss and the Swedes, it wouldn’t be all that crazy in Canada.

Twice this year, in January and again in October, Poloz has decreased the Bank’s overnight rate by 25 basis points, to where it now stands at 0.50 per cent. Even with an overheated housing market in Toronto and Vancouver, the Bank is in no hurry to raise its key rate, because it remains concerned about plunging commodity prices in the energy and natural resource sectors that are drivers of the Canadian economy. Moreover, the core inflation rate of 2 per cent in November is in the middle of the Bank’s target range.

Long gone are the halcyon days of exchange rate parity with the U.S., to say nothing of the loonie being worth even more than the USD. Back then, the loonie was a ‘petro currency’ trading above par in 2010, when oil was selling at over $140 per barrel.

The Bank likes to keep its overnight rate higher than the Fed’s, but now they’re identical at the upper end of the U.S. rate. Yellin’s increase sparked a further selloff of the loonie, driving it below 72 cents U.S. Thursday — its lowest level in 11 years.

As BMO Chief Economist Doug Porter observed in the bank’s weekly Focus report Friday: “The late year dive in the Canadian dollar cemented the currency’s spot as one of the big economic stories of 2015.”

Year to date, he noted, the loonie was down almost 17 per cent so far this year, making this its second-worst year on record, trailing only the 18.6 per cent plunge during the 2008 financial crisis. Since mid-October alone, the loonie has lost a nickel to the greenback, and is down 2 cents just since the Fed rate hike.

Long gone are the halcyon days of exchange rate parity with the U.S., to say nothing of the loonie being worth even more than the USD. Back then, the loonie was a “petro currency” trading above par in 2010, when oil was selling at over $140 per barrel. The loonie traded below 72 cents again Friday, with oil at just over $34.50 per barrel.

As BMO’s Porter writes in his Friday note: “The heaviest weights on the C$ have been plummeting oil prices, the divergence between U.S. and Canadian monetary policies, and the underlying strength in the U.S. dollar.”

Poloz will not have to explain this in his economic briefing to the federal, provincial and territorial finance ministers at their annual year-end meeting in Ottawa on Sunday and Monday. The loss in royalties in Alberta, and revenues in Ottawa, is $1 billion for every $5 drop in the price of oil. Just in the six weeks since the Trudeau government took office, oil has plunged nearly $15.

As for the loonie, a cheap Canadian dollar is undoubtedly good for exports — especially to the U.S., which now has a virtually full-employment economy with a jobless rate of only 5 per cent (compared to 7.1 per cent in Canada, with Alberta at a shocking 7 per cent). But a low dollar is not good for the consumer price index, especially with Canadians paying more for California and Florida fruits and vegetables over the winter months. And it drives the snowbirds crazy, with January approaching.

But this is the hand Finance Minister Bill Morneau has been dealt as he meets his provincial and territorial colleagues for the first time. He’s expected to tell them the window for his first budget will be sometime between late February and mid-March. The agenda also includes a discussion on possible increases to employer and employee premiums in the Canada Pension Plan, something Ontario Liberal Premier Kathleen Wynne has been lobbying for.

But two-thirds of the provinces need to buy into a CPP premium increase, and it’s not clear there’s such a consensus, especially in a weak economy. The Canada Child Benefit, which the Liberals plan to have means-tested, is also on the agenda, as is promised Liberal infrastructure spending as straight-up transfer payments to provinces and municipalities.

In the spirit of the season, the provinces will be saying to Morneau, “Please, sir, I want some more.”

L. Ian MacDonald is editor of Policy, the bi-monthly magazine of Canadian politics and public policy. He is the author of five books. He served as chief speechwriter to Prime Minister Brian Mulroney from 1985-88, and later as head of the public affairs division of the Canadian Embassy in Washington from 1992-94.The views, opinions and positions expressed by all iPolitics columnists and contributors are the author’s alone. They do not inherently or expressly reflect the views, opinions and/or positions of iPolitics.

The views, opinions and positions expressed by all iPolitics columnists and contributors are the author’s alone. They do not inherently or expressly reflect the views, opinions and/or positions of iPolitics.